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Do you have a “Cash Cow” or a “Cash Hog”?

Cash Managment is critical to the success of a business. We often hear that Cash is equally important with profit…but do we know why it is paramount that we control Cash? Does your staff know? What are the common pitfalls as it relates to Cash and the businesses that have failed because of it?

Does your business consume cash or create it? This may sound like a simple question to answer but let’s look at the cash cycle and working capital requirements. Take a look at your largest sales item or category. Do you need cash to fulfill the sales before you collect on it? If you were to 10x your sales in the next 30 days would this put a strain on your cash reserves and would you need to go to an external source to get Cash such as a bank or parent company?

Most startups have great control over Cash but as the business grows it often is overlooked. As John Warrillow wrote about in “Built to Sell”, the Cash Cycle of your business can dictate the sell-ability of your business.

The Cash Cycle Defined

Effectively it is the timing of the flow of money. When the Cash enters and when it exits and how much is left behind. Often the Cash is exiting in the form of expenses or COGS (cash of goods sold) before it enters as an account receivable paid. The most effective cash cycles are the ones that finance their own growth in revenues. The least effective are the cash cycles that need extra funds to finance any growth in revenues. The Cash Cycle once understood in a business dictates working capital that is needed for growth.

Let’s look at some of the items that appear on the financial statements of a business and determine if they are a Cash COW that is paying its own way and helping improve the cash cycle or if it is a Cash HOG that is consuming cash before paying its own way and hurting the businesses ability to grow.

Cash Item

CASH COW or CASH HOG

Description and Discussion

Inventory (Balance Sheet)

HOG

In almost every case inventory is a HOG.

It consumes the CASH and holds onto it until the business sells the inventory. Too much or stale inventory is often one of the factors that may have a business look profitable on the books but it can be so financially unhealthy that the business fails from this mismanagement.

Some Questions to ask?

Do you measure each sku’s turnover, how accurate can you predict the use of the inventory?

Can you move to Just-in-time Operations, made to order, etc.? What is your inventory management system? Do you purchase slow-moving inventory? Can you eliminate the purchase of inventory entirely?

Can you find other means that improve your cash cycle? Find ways to purchase in smaller quantities especially if the inventory is not your main offering?

Can you decrease your offerings to limit inventory requirements?

What to do with this information?

Figure out your inventory turnover ratio on the individual product before investing in it. How much and over what period? When does the Cash get back into the business?

Watch out for the “BAIT” and add a cost of capital to the calculations. Others are offering great bulk deals, purchase commitments that appear to be a no-brainer as they would on the surface bring down the cost of sales and increase profitability, however if they don’t match your inventory turnover it can destroy a profitable business.

COGS (Income Statement)

HOG

COGS (Cost of Goods Sold) should be seen as a HOG.

It consumes cash and hurts your cash cycle. This consumption negatively impacts the ability of the company to scale up or down to match sales cycles. It can create misalignment internally and hurt the customer experience and the company reputation as a result. The margins may be great but if the Cash Cycle is not in check, growth in revenues can be hard.

Some Questions to ask?

Any costs spent before collection hurts the cash cycle.

Can you move these expenses to align with cash collection?

Can you pay on terms that improve the cash cycle?

Can the customers finance the COGS?

What to do with this information?

Look at your standard transaction; can you move the Cash consumption to a later point in the cycle?

What can your suppliers do to help you out with this?

Overhead (Income Statement)

HOG

Overhead is an obvious HOG.

Payroll, Admin, Building, anything that is paid to run the business that is not directly related to the sales of goods. This is straight cash consumption.

Some Questions to ask?

Do you have long or short-term commitments on overhead?

How do you scale the admin operations to match requirements with short-term commitments?

How reliable is your revenue stream? Can you accurately predict 12 to 36 months away before entering a long-term commitment?

Can you outsource with scale-ability and improve profitability?

What to do with this information?

Keep an eye on how much is tied into long-term costs that cannot be scaled up or down with the flow of Revenue.

Be creative with the admin operations. There can be many ways to solve the needs of the company.

Equipment (Balance Sheet)

COW or HOG

Equipment ties up Cash and therefore a HOG, however if used correctly it can be a COW

Cash that is tied up in equipment and facilities is not liquid. However, depending on your financial forecast, the equipment can actually improve cash flow and can be seen as a wise investment.

Some Questions to ask?

How reliable is your cash forecast? 12 to 36 months out? What risks are assessed or should be assessed?

When will the equipment become obsolescent or a liability?

What trends are happening in the industry around you?

How many months Cash do you have on hand if you acquire the equipment?

What to do with this information?

Ensure that you know your cash cycle, working capital requirements and cash reserves before you consume cash in equipment.

Consider a short-term lease or rental if some questions are not yet answered.

Cash Consumed with no short-term return on the investment is definitely a HOG.

Many businesses have failed because they didn’t understand the impact on the availability to cash once it is removed out of the business.

Some Questions to ask?

How reliable and stable is the 12-36 month forecast?

What are your cash requirements to scale with the sales forecasts?

What risks are assessed to the forecast? What variables can change the forecast?

What to do with this information?

Ensure you have knowledge of the entire business cash requirements before investing Cash out of the company.

Collections is a Key to a successful Cash Cycle that in turn increases the value of a business. Let’s look at the common Collections procedures that are very typical today for most businesses and how they affect the Cash Cycle:

Collections procedure

CASH COW or CASH HOG

Description and Discussion

Retainer, Deposit, and Prepaid Sales

COW

Any collection of Cash before Expenses improves the Cash Cycle and therefore is a COW.

Simpler said than done, yes, but this can be a big factor in helping increase the value and reliability of your business

Standardize your sales process and ensure Cash is part of the process

Align sales compensation

Some Questions to ask?

Does your sales compensation promote or detract from the collection of this?

Do you have a standard and documented process that includes cash collection?

How do you account for the prepayment?

What to do with this information?

Standardize your sales process and ensure Cash is part of the process

Align sales compensation

At the time of Delivery of Sales

COW or HOG

Depending on the timing of the expenses related to the transaction, this may be seen as a COW or a HOG.

Some Questions to ask?

Does your delivery of goods or services start and finish at the time of the transaction?

Does the COGS cash consumption occur after the collection?

Is the business selling existing inventory or custom ordering?

When is the customer engaged in the “sale”?

How often does the cash collection get delayed? Why?

What to do with this information?

Measure any exceptions to the process

Lean on suppliers with terms

Look at ways to change the cycle

On Account and Collection after sale has been completed

HOG

The Cash is consumed in the COGS yet the payment has yet to come. Any period of time is a definite HOG.

Some Questions to ask?

What are the average days in Accounts Receivable?

Which Accounts extend the average?

Does the process or compensation support this as the “easy” option?

Do you have a standard and documented process that includes cash collection?

Why is this the accepted process?

If the sales multiplied, would this cause a cash constraint to fulfill?

What to do with this information?

Keep an eye on the days in AR.

Consider changing the process to position favorably a deposit or prepayment.

Ensure you have a cost of capital calculated into your profitability of the customer as you may be better off firing a few of your customers that routinely use the cash beyond any reasonable terms. Include this in your sales compensation as a cost of a transaction.

The Cash Cycle is often ignored as the belief that one just has to put up with it or sell through it, however strategies exist that can help improve the Cash Cycle and turn your business into more of a Cash Cow and finance it’s own growth which will put less limits on your growth and your company value.

Get help, often a business needs an external perspective to help see and adapt itself to a more valuable entity.

Ask your accountant or advisors how this would work and what the benefits of it would be.

Align your staff with policy, process, and compensation to get the best results.

I recommend receiving your free Value Builder Score on our website that will help identify this and other ways to improve the value of your business for yourself, your employees and any future sell-ability of it. Many have found that they can increase the value of their business by 71% by improving the score on the assessment.